DeFi Vs. Traditional Finance: Differences and Advantages

Decentralized finance (DeFi) is an upcoming industry that has a feature in revolutionizing the traditional finance sector. The primary drive for the discussion on DeFi vs. traditional finance comes from the need for an open, transparent, and secure financial system. It is no surprise that DeFi is coming up as an alternative between the two.

But what are the key differences we should note between them, and what are their advantages which will help you discover the better choice?

What is Decentralized Finance?

At its simplest, DeFi constitutes an open financial network that runs on software built on open-source blockchain. Additionally, it involves building financial products and services on top of a blockchain to promote or enhance the development of an open financial system.

DeFi works to change the financial sector by acting as a choice for centrally-governed institutions, including banks. Such institutions historically have been acting as financial intermediaries.

Besides, DeFi gives a chance for users to have tools that give them total control. With reducing operational risks, this functionality that the new system offers makes it the best replacement for the current system.

Advantages of Decentralized Finance

• DeFi is all-inclusive, promotes equitable opportunity, and eliminates race, wealth status, or other conflicting factors. In addition, it allows a peer-to-peer model that removes the greedy middleman (Banks), dramatically lowering costs and increasing returns, which is a win-win.
• DeFi allows you to earn interest (yield) on your deposits again, unlike banks that pay depositors nothing, lending out your money and returning profits to shareholders & top management, promoting wealth inequality.
• DeFi allows for passive income as the peer-to-peer model allows one to be the bank (lend out their money) and benefit directly by earning passive income (interest) or borrow money at much lower rates due to no greedy mediator. DeFi is non-discriminatory; everyone is welcome.

Use Cases of DeFi

1. Peer-to-peer (P2P) borrowing and lending have become popular in the DeFI space.
2. The introduction of DeFi gives the space a chance to access developed payment solutions for businesses and individuals to send and receive crypto payments.
3. DeFi also enables the creation of tokenized derivatives and synthetic assets.
4. Like traditional trading platforms, DeFi platforms offer margin trading as an option to obtain funds from a DeFi platform.

What is Traditional Finance?

They are mainly centralized authorities that manage funds and assets on the user’s behalf. In this type of system, all financial categories like lending, borrowing, and trading require a borrower or receiver, lender and a financial intermediary that processes all such financial transactions.

The significant difference between traditional finance and DeFi is that transactions are processed through a central authority. On the other hand, DeFi automates the transaction settlement process with minor human intervention.

Benefits of Traditional Finance

• Apart from the fact that one cannot fully control their funds, traditional finance has some advantages. It is the oldest financial system in the world. Here are some benefits of the system;
• Better flexibility- they offer better payment flexibility when compared to decentralized finance.
• They have better returns as they offer a better interest or return on investment (ROI) on deposits. This applies to lending as well as depositing.
• Users can access customer service to raise a ticket and seek investment advice and other services in general.

Examples of Traditional Finance Institutions

• Non-Banking Financial Companies (NBFCs) offer loans to customers based on their CIBIL record
• Gold collateralized loan- some institutions offer fiat loans to customers who can offer gold as collateral.  

Why is DeFI Better Compared to Traditional Finance?

TradFi is Opaque, with minimal transparency and no accountability. Made up of bankers sitting in front of congress, stating they had no responsibility for the negative consequences with endless resources to bleed any individual or small business dry before they have a shot of winning.

TradFi also gives preferential treatment to the wealthy (insiders club), promotes systemic racism, extracts money from the poor (Late Fee’s, High Interest), and denies access to financial services. However, DeFi gives a chance to everyone as long as they are connected to the internet. It is asymmetrical for the Banks having preferential treatment, setting all the rules (any of which they can change to improve for themselves and impoverish their customers).

Additionally, TradFi is only open for banking hours and closed on weekends, and you are at the mercy of their time, yet if you are late, you pay late fees. The good thing with DeFi is that it is present whenever and whatever time you need, as long as you have the internet and a device.

So, Which Stands Out?

Taking in all the characteristics of the two, DeFi stands out as an alternative to traditional finance, as it does away with today’s financial bureaucracy, which is a burden of today’s financial system.

Besides, DeFi allows for the use of digital ledger technology, making it possible for people to gain complete control of their assets and personal financial data.

In addition, introducing open-source and developer tools allows users to experiment with more financial instruments as decentralized finance gains traction. One can work without restrictions, upgrading financial products and instruments in the financial sector.

Bottom Line

While the use of digital ledger technologies in the global financial system is still early, one cannot dispute this technology’s ultimate potential. DeFi has all the features required to revolutionize the financial sector in growing data and privacy security concerns.

The thing is, Defi has the potential to give people a chance to access banking services in areas where traditional finance has failed, as such, underscores its massive potential. 

Vincent Munene is a freelance writer and a great blockchain enthusiast. Blockchain has changed his life in terms of financial freedom and in return, he likes to educate people and keep them up to date on everything blockchain. He is a Biochemist by profession and also loves to play the piano.